GBS 205 Business Law Edd Welsh, Attorney-at-Law
GBS 206 Business Law (UCC) Office: BPO33 Phone: 461-7712
GBS 207 Business Law (General) E-mail: eddwelsh@mail.mc.maricopa.edu
CONTRACTS OUTLINE
I. GENERAL INTRODUCTION
A. DEFINITION. "A contract is a promise, or set of promises for breach of which the
law gives a remedy or the performance of which the law in some way recognizes as a
duty." (Restatement, 2D)
B. CLASSIFICATION.
1. Formal.
a. Under Seal
b. Negotiable Instruments -- i.e. check, etc.
2. Informal. All others.
3. Express. Where the manisfestation of mutual assent is by written or spoken words.
4. Implied-In-Fact. Where assent is manifested by conduct other than words.
5. Implied-In-Law. (Quasi-contract). Where a contractr is implied without regard to
the assent of the parties.
6. Bilateral. A promise given for a promise.
7. Unilateral. A promise given for an act.
C. LAWS GOVERNING CONTRACTS.
1. Common Law -- covers Land and Services.
2. Uniform Commercial Code (UCC) -- Sale of Goods and personal property. The
purpose of the UCC per UCC 1-102 (2) is:
a. to simplify, clarify and modernize the law governing commercial transactions
(concerning personal property).
b. to permit the continued expansion of commercial practices through custom,
usage, and agreement of the parties.
c. to make uniform the law among the various jurisdictions.
D. FIVE MAIN SUBJECT AREAS.
1. Formation. Is there a valid contract?
2. Defenses. Any defects in the contract?
3. Third Party Beneficiaries & Assignments/Delegations. Are there any third party
rights?
4. Breach/Discharge. Was the contract breached or discharged?
5. Remedies. What corrective actions available for a breach?
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II. FORMATION
A. The first requirement of a contract is for the "Manisfestation of mutual assent," and
this is usually made up of an offer and an acceptance.
1. Offer. Restatement, 2d, . 24, defines an offer as: "a manisfestation of willingness
to enter into a bargain, so made as to justify another person in understanding that
his assent to that bargain is invited and will conclude it."
2. The offer is crucial because it gives only the offeree the power to accept the
promise.
B. An Offer consists of four main elements:
1. It must show present intent. A reasonable expectation must be created in the mind
of the offeree that the offeror is not willing to enter into a contract and not later.
a. Circulars, Advertisements, Catalogs, etc. General Rule: They are considered
preliminary negotiations but can be offers.
1) An advertisement is an invitation for offers by the Seller who is stating the
price at which he will receive an offer.
2) But, if the advertisement is definite and certain in its terms and the offeree
can be clearly identified, then the advertisement could be an offer.
b. Examples:
1) "First Come, First Served …."
2) "A $10,000 mink stole for $10 for the first 10 people who are at our doors
promptly at the start of business …."
2. Offeree must be definite and ascertainable. The larger the group, the less likely an
offer was made.
3. The terms must be definite and certain. A contract will fail for lack of certainty if
enough of the essential terms are missing. WHY? A vague contract can't be
enforced by the courts.
a. Essential terms of a contract would include:
1) Identity of the offeree None
2) Identity of the subject matter None
3) Price 2-305
4) Time of Payment, deliver of performance 2-308, 309, & 310
5) Quantity 2-306
6) Nature of work to be performed None
b. But, note above that the UCC can fill certain gaps and prevent a contract from
failing.
4. The Offer must be communicated to the offeree.
C. Termination of an Offer. By a lapse of time, rejection of offeree via an express
rejection of counteroffer, by operation of law or by revocation by offeror.
1. LAPSE. With expiration date set by either the offeree, offeror, or the market in
general.
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2. REJECTION BY OFFEREE
a. Expressly -- outright
b. Counteroffer (Exception -- a counteroffer can co-exist with the original offer
and not reject it.)
3. BY OPERATION OF LAW
a. Illegality
b. Insanity or Death of the parties
c. By destruction of the subject matter
4. BY REVOCATION BY OFFEROR. Two key questions to ask:
a. Was there a revocation? Courts are reluctant to force people into a contract.
b. Was the revocation properly communicated to the offeree?
1) A revocation is generally effective when received by the offeree.
2) It can be communicated by a third party or indirectly if the third party is
reliable and has accurate information.
c. Limitations on the power of the Offeror to revoke:
1) Option. Offeror temporarily sells his right to revoke when the offeree
gives consideration for the offeror's promise not to revoke before a set
time.
2) UCC 2-205 -- MERCHANT FIRM OFFER RULE. This is a major
change in the common law.
a) An offer made in a writing signed by a merchant is open for the
period specified or for a reasonable time not to exceed three months
and needs no consideration.
b) If no time is stated, then three months is considered reasonable.
3) Unilateral Contracts (per restatement, #45). Doctrine of Part Performance
states that a contract calling for part performance is open for a reasonable
time or for the period specified.
4) Detrimental Reliance by Offeree. The more an offeree has relied on an
offer is a reasonable way, the more the court is going to find a way to limit
the power of the offeror to revoke the offer.
D. Acceptance. Basic rule is that an offer can be accepted by the offeree in the manner set
forth by the offeror or offeree, but it must be absolute, unequivocal, and communicated to the
offeror.
1. Words or conduct can constitute acceptance, but silence alone is not acceptance.
But, please note the following exceptions:
a. Use of products + silence = Acceptance. Why? To prevent unjust
enrichment on part of offeree who uses the goods/services.
b. In some trades or industries, an offeree may have a duty to speak and his
silence will be considered an acceptance.
c. A course of dealings between parties may mean that silence is acceptance for
these particular individuals.
2. Mirror Image Rule. At common law, acceptance had to "mirror the offer" or it was
considered a counteroffer.
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3. UCC 2-207. Modified the Mirror Image Rule for the sale of goods between
merchants so that acceptance can be effective even though it states additional terms
or different terms.
a. Either merchant 1 party can avoid making a contract under UCC 2-207:
1) The offeror can limit acceptance to the original terms.
2) The offeree can make his acceptance conditional upon the offeror agreeing
to the different/additional terms.
b. These additional terms are to be construed as proposals for additions to the
contract.
c. This Special Merchant's Rule says a contract is formed and any additional
terms will become a part of the contracat unless:
1) They materially alter the original contracts, i.e. reallocate risks, benefits,
or remedies involved.
2) The original offer is expressly limited to its terms.
3) The offeror rejects them within a reasonable time.
4. Manner of Acceptance.
a. Common Law. Any different or additional terms in the acceptance made it a
rejection or a counteroffer (MIRROR IMAGE).
b. UCC 2-206. Liberalizes the Common Law: States that an offer may be
accepted "by any medium reasonable in the circumstances."
c. An offeror can still limit acceptance to a particular means but unambiguously.
d. An acceptance by an unauthorized means can be effective if it was received by
the offeror while the offer was still open.
E. CONSIDERATION. Defines as a "legal benefit received by the promisor or a legal
detriment suffered by the promisee, and which was requested by the promisor in
exchange for his promise to the promisee" (per Restatement, 2d,.75).
1. Two key elements. The bargain and the legal detriment.
a. The Bargain. Was there a "bargained-for" exchange? Did the promise induce
the detriment and the detriment induce the promise?
1) If there was no bargain, there could have been a conditional gift, i.e.
"Come to my house and I'll give you my old lawn mower."
2) The test is whether the act or forbearance of the promisee would be any
benefit to the promisor.
b. The Legal Detriment. This is a legal concept, not a material concept, as it
consists of:
1) Not doing what you are free to do, OR:
2) Doing that which you are not required to do.
c. In general, courts do not inquire into the adequacy or fairness of consideration,
but if something is entirely worthless (token consideration) it is insufficient
and would be deemed close to a gift.
2. Specific Consideration Problems.
a. Settlement of a disputed claim.
1) If claim is valid -- surrendering it is consideration.
2) If claim is invalid -- surrendering it is not consideration.
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3) If party thinks claim is valid but it is not -- surrendering it is consideration
if there was a good faith belief that the claim was valid.
b. Pre-Existing Duty Rule. Generally, the promise to perform an existing duty is
not consideration. But there are many exceptions.
1) If this Rule was applied literally, then contract modifications would not
exist. Thus, courts find ways to avoid this Rule.
2) But, if coercion or extortion is involved, the courts will uphold this Rule.
3) The modern trend, such as the UCC and the Restatement Second, is to
eliminate this Rule because it has so many exceptions.
4) Method of avoiding this Rule:
a) If new or different consideration is promised.
b) For a legitimate dispute, Courts use recision.
c) Unforeseen difficulty can justify a change.
d) UCC 2-209 provides that any contract subject to the UCC (involving
sale of goods) needs no consideration to be binding where both parties
are acting in good faith.
5) Commom pre-existing duty situations:
a) A powerful debt or wanting to pay less for his debt.
b) Employment situation where employee wants more money to do an
existing job or an employer wanting to pay less than agreed upon for
the same job.
c) A builder wanting more money to complete a job/project.
3. Doctrine of Mutuality. Consideration must exist on both sides of the bargain. If
not, there is an "illusory promise" with one party being bound, but not the other,
and the contract will fail for lack of consideration.
a. The policy considerations behind this rule are:
1) One party is free to get out of the contract but one is not. Thus, the
reliance of the party bound is what the courts will be focusing upon.
2) There is a disproportionate allocation of risk, as the party bound has all the
risk.
b. Certain situations exist where mutually exists even though the promisor has
some choice or discretion. Thus, these are also ways this Rule is avoided or
overcome:
1) "Requirements" and "Output" contracts. See UCC 2-306, where a party
agrees to buy all that another makes or all that he requires for his own
operation, requires parties to act in "Good Faith."
2) A Conditional Promise. Is enforceable unless the "condition" is entirely
within the control of the promisor.
3) The right to cancel or withdraw. If restricted, i.e. within 60 days notice,
etc., is enforceable.
4) If best efforts are implied on part of one party.
5) Voidable promises. Such as contract with minors.
6) Unilateral/Optional contracts.
a) Unilateral Contract. If one has started to perform on it.
b) Optional Contract. Where one has purchased time to decide.
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4. Substitute for Consideration. Some items can substitute for consideration.
a. BUT, moral obligation nor past consideration is valid to support a contract.
b. A promise to pay a debt barred by the Statutes of Limitations will be
considered as consideration. Courts are willing to uphold such a promise if:
1) It is in writing, signed by the debtor.
2) It acknowledges the debt.
a) It will be enforced only to its terms and not to its original debt if there
is a difference.
b) ARS 12-408 acknowledges this doctrine in Arizona.
3) To reaffirm a voidable promise needs no consideration, i.e. minor
reaffirms a debt upon reaching majority.
4) Promissory Estoppel. Where a promise made after a benefit is conferred
needs no new consideration.
F. PROMISSORY ESTOPPEL. This is really a situation where no consideration exists
and the courts are saying that no consideration is needed because of the circumstances
involved.
1. Historically it existed in family situations where one family member promised
another to do something for another. The promisor failed to keep the promise, the
promisee relied detrimentally on the promise and was harmed in some manner.
2. Key components:
a. A promise
b. Foreseeable reliance on the part of the promisee.
c. Reasonableness of the reliance.
d. Unjust enrichment by the promisor or harm to the promisee.
3. Modern application on franchising and contractors.
a. Franchising. Red Owl Store, Wisconsin case, where a potential franchisee
works for a franchisor who doesn't grant a franchise. The key factor of this
situation are:
1) The franchisor doesn't make an offer but rather a general type of promise
that doesn't qualify as an offer.
2) The remedy available here is to give the franchisee or potential franchisee
a limited remedy: their reliance expense and not the "benefit of the
bargain."
b. Contractors. General situation is where a general contractor uses a
subcontractor's bid as part of his overall bid, and the subcontractor later
attempts to back out of his bid.
4. NOTE: Not all reliance is protected and when a remedy is available, it is limited to
recovery of expenses.
III. DEFENSES AND DEFECTIVE AGREEMENTS.
A. The five main defenses are: capacity, Statute of Fraud, illegality, mistakes, and
unconscionability.
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B. Capacity includes:
1. Infancy (up to 21, 18 in Arizona). Minor liable only for necessities, but can affirm
upon attaining majority.
2. Mental incompetents (including drunks). Can contract/affirm during lucid
intervals.
C. Statute of Fraud (S/F). A 3-part analysis. If unclear -- if it is oral or written, make
reference to S/F. Ask:
1. Is this item required to be in writing? If so, it would be:
a. A promise to pay debt of another must be made to creditor.
b. An agreement that cannot be performed within a year.
c. Contract involving an interest in land including leases of a year or more.
d. Agreement not to be performed during promisor's lifetime (apply in Arizona
and California).
e. Sale of goods over $500 (UCC 2-201), and personalty not goods or securities
(i.e. royalties and sale of contents) over $5000.
f. Promises to marry.
2. Is the required writing sufficient?
a. It must identify the parties, quantity, subject matter, maybe price, and recite the
consideration, and include signature (or initials or letterhead) of party charged.
b. These key items need not be in a single document as long as all the documents
can be tied together.
3. Are there any mitigating doctrines to offset the S/F? Courts dislike S/F and look to
ways to reduce its impact. Methods used by courts:
a. Sales of Land. Doctrine of Part Performance will satisfy a suit for specific
performance.
b. Contact not to be performed in a year. If totally performed, or can be
performed, or terminated, court will not apply S/F.
c. UCC Goods over $500. S/F satisfied if:
1) They are custom/specially built goods.
2) An admission of same is made in court.
3) The goods are paid for or accepted.
4) A written confirmation of goods binding sender is not objected to within
ten days of its receipt by sender.
d. Doctrine of Estoppel. To prevent unjust enrichment, S/F not allowed in
quantum merit suit, except real estate broker not use a quantum merit suit,
except real estate broker not use a quantum merit action (as S/F is strictly
construed against this profession).
e. Promise to pay debt of another. S/F will not apply if this promise was self-
serving by promisor.
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D. Illegality. Involves contracts involved in restraint of trade. Courts will not enforce a
contract that violates a gambling statute, a usurious one (Arizona has no usury rule),
violates a licensing statute (non-licensed contractor or real estate broker), involving use
of goods in illegal way, or contracts made under duress.
1. Covenant not to Compete. It will be enforced if:
a. it is necessary to carry out contract.
b. it is reasonable in scope and geographical area (covenant will be short in urban
and long in rural areas.)
2. Remedies for Illegality. Apply Doctrine of Severance to cut out illegal part to save
contract. In Arizona, one can sue for recision of innocent misrepresentation.
E. Mistakes. May be unilateral, mutual, or a misunderstanding (latent ambiguity) or a
mistake of an intermediate party.
1. Unilateral. Generally no relief granted, but this may depend upon:
a. amount of mistake (if real loss, or to prevent bankruptcy).
b. ability to restore the status quo (if so, relief given).
c. negligence of mistaken party.
d. the scienter of non-mistaken party (if he knew, relief may be available to
mistaken party).
2. Mutual Mistake.
a. If both parties make contract based on fundamental assumption, relief granted.
b. If both parties contract in conscious ignorance (rock-gem), then no relief.
3. Latent Ambiguity. Such as:
a. both parties use same description not knowing it meant something different to
the other (peerless ship, no mutual assent, court held).
b. both knew of the ambiguity, but it meant something different to each.
4. Mistake of Intermediate Party (telegraph, etc.). The one choosing the transmitter is
held to amount in message, unless party receiving message is or should be aware
that mistake was made.
5. General Rules.
a. If one party knew, or should know, of the mistake, the contract is construed
against him.
b. A contract always construed against its maker.
F. Unconscionability. Is applied in consumer transactions, rarely in commercial cases
involving gross inequity of bargaining power (procedural unconscionability) and
commercially unreasonable terms (substantive unconscionability). Courts are reluctant
to allow a party to deny a warranty, to limit remedies, or to claim all the goods for one
default.
IV. Third Party Beneficiaries & Assignments/Delegations
A. Intended Third-Party Beneficiaries -- A person to whom the contracting parties intended
to give rights under the contract at the time of contracting acquires legal rights under the
contract.
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1. Creditor Beneficiary Contract -- A creditor beneficiary contract usually arises in the
following situation:
a. A debtor borrows money,
b. the debtor signs an agreement to pay back the money plus interest,
c. the debtor sells the item to a third party before the loan is paid off, AND
d. the third party promises the debtor that he will pay the remainder of the loan to
the creditor.
2. Donee Beneficiary Contract -- A contract entered into with the intent to confer a
benefit or gift on an intended third party.
a. A life insurance policy with a named beneficiary is an example of such a
contract.
b. If the promisor fails to perform the contract, the donee beneficiary can directly
sue the promisor.
B. Incidental Beneficiaries -- Those who will be benefited by the performance of a contract
but has no rights by virtue of it.
1. Direct Incidental Beneficiary -- When the performance of the contract will confer a
direct, although not intended, benefit on a third person, that person is a direct
incidental beneficiary.
2. Contingent Incidental Beneficiary -- When the third party will benefit only if the
obligee of the original contract takes some further action that will benefit the third
person.
C. Assignments -- An assignment is a transfer of rights. The party making the assignment
is the assignor, and the person to whom the assignment is made is the assignee. The
assignee's rights are no greater or less than those of the assignor.
1. Assignment of Right to Money.
a. Collection of a debt
b. Future Rights -- what is expected in the future.
2. Consent to Assignment of Rights -- must have obligor's consent.
a. Terms of a contract expressly prohibit assignment.
b. Contracts that are personal in nature.
c. The assignment would materially alter the duties of the obligor.
3. Assignment of Right to a Performance.
a. Increasing Burden of Performance -- if the assignment increases the burden of
the obligor in performing, an assignment is ordinarily not permitted.
b. Personal Satisfaction -- when the goods to be furnished must be satisfactory to
the personal judgment of the buyer, the buyer may not substitute the personal
judgment of an assignee.
c. Personal Services -- An employer cannot assign to another the employer's right
to have an employee work.
d. Credit Transaction - when a transaction is based on extending credit, the
person to whom credit is extended cannot assign any rights under the contract
to another.
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D. Delegation of Duties -- A transfer of contractual duties by the obligor to another party
for performance. Unless otherwise agreed, most duties can be delegated.
1. Expressed
a. Oral
b. Written
2. Implied -- Unless required to be in writing, under the Statute of Frauds.
3. Partial Delegation of duties.
4. Duties That Cannot Be Delegated
a. Personal service contracts. Such that call for personal skills, discretion, or
expertise cannot be delegated.
b. Contracts where obligee places special trust on obligor--such as contracts to
hire accountants, lawyers, doctors, etc.
c. Contracts whose performance would materially vary if the obligor's duties
were delegated.
5. Delegator's Liability
a. The obligor-delegator remains legally liable to the obligee for the performance
of the contract.
b. Novation -- An agreement that substitutes a third party for one of the original
contracting parties; the new party is obligated to perform the the contract.
6. Delegatee's Liability
a. When a delegation of duties contains the term "assumptoin," of "I assume the
duties," or other similar language; the delegatee is legally liable to the obligee
for nonperformance.
b. Upon declaration of duties, the delegatee is not liable to the obligee for
performance of the contract.
7. Obligee's Liability
a. If the duties are properly delegated, the obligee is obligated to accept the
delegatee's performance.
V. Breach/Discharge
A. Definition of Breach -- A breach is the failure to act or perform in the manner called for
by the contract.
B. Anticipatory Breach
1. Anticipatory Repudiation -- When a party expressly declares that performance will
not be made when required.
2. Anticipatory Repudiation by Conduct -- The anticipatory repudiation may be
expressed by conduct that makes it impossible to perform. For example, if a farmer
who made a contract to sell an identified mass of potatoes, sells and delivers them
to another buyer before the date specified for the delivery of the potatoes to the first
buyer.
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C. Waiver of Breach -- When one party may be willing to ignore the breach. The party
waiving the breach cannot take any action against the other party.
1. Existence of Waiver
a. A party may express or declare that the breach of the contract be waived.
b. Silence or failure to object in a timely fashion is an expression of forgiving the
breach. Allowing the other party to continue performance without objecting,
waives the right to raise that objection when sued for payment by the
performing party.
2. Scope of Waiver
a. Only to the matter waived -- for example, a party can waive a condition of
lateness of a job, but it does not waive the manner in which the job should be
completed. (quality of work)
3. Repeated Breaches and Waivers
a. May modify original contract
4. Anti-Modification Clause
a. Specified in the contract that the contract shall not be modified by repeated
breaches or waivers. The original contract remains as agreed to.
5. Reservation of Rights
a. When a party is willing to accept a defective performance, but does not wish to
surrender any claim for damages for the breach.
VI. Remedies
A. Remedies upon Anticipatory Repudiation
1. State that the performance at the proper time will be required.
2. The contract has been definitively broken; bring a lawsuit against the repudiating
party.
3. Repudiation is an offer to cancel the contract; the offer can be accepted or rejected.
If accepted, there is a discharge of the original contract.
B. Action for Damages
1. Measure of Damages
a. Compensatory Damages -- A sum of money that will compensate for the actual
loss.
b. Nominal Damages -- An injured party who doesn't sustain an actual loss from
a breach of contract is entitled to a judgment of a small sum.
c. Punitive Damages -- Damages in excess of actual loss, for the purpose of
punishing or making an example of the defendant. (Sometimes called
exemplary damages.)
d. Direct and Consequential Damages
1) Direct Loss -- is necessarily caused by breach.
2) Consequential Loss -- does not necessarily follow the breach of the
contract, but does so because of the circumstances of the injured party.
e. Mitigation of Damages
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1) The injured party is under the duty to mitigate the damages if reasonably
possible.
a) Effect of failure to mitigate damages
1. Limits the recovery by the injured party to the damages that
would have been sustained had the injured party mitigated the
damages.
b) Excuse for failure to mitigate damages
1. There is no duty to mitigate damages when the injured party has
no reasonable way to reduce damages.
C. Rescission
1. Right to Rescind
a. Where there is a material breach of contract, the aggrieved party may rescind
the contract.
b. May be governed or controlled by civil service statutes or similar regulations.
c. The rescinding party must restore the other party to that party's original
position.
d. Watch out -- the party who rescinds could be guilty of repudiating the contract.
2. Judicial Rescission
a. When party breaking contract doesn't recognize the right of the aggrieved party
to rescind the contract, the aggrieved party may bring an action.
1. Court will declare that the contract has been rescinded.
2. Court will specify what payments or exchanges of property are to be made
by the parties to return to the conditions before the contract was made.
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